an economics scrapbook

The face of the river, in time, became a wonderful book . . . which told its mind to me without reserve, delivering its most cherished secrets as clearly as if it had uttered them with a voice.
-- Mark Twain

What happens when the people in charge of coming up with a solution to the banking crisis are the same people who created the banking crisis in the first place? Let’s take a peak into the kitchen on Capitol Hill to see what they’re putting together now. Mmmmm… do I smell books cooking? It seems Washington, in all its glorious cronyism, is hard at work again helping the banking system mix up a final solution to the problem of mortgage backed security debt.

Some have described it as the biggest heist in history. The largest banks in America systematically defrauded investors over a span of years in the effort to reap huge profits, salaries and bonuses. The victims were individual homeowners, foreign investors and pension funds worldwide along with anyone else who’s net worth has been hit by the current economic downturn. The blame does not lie entirely on banks and financiers. The responsibility of managers who bought into the racket must be questioned, as well as those who decided to sign up for loans they could never possibly pay on the salaries they were bringing in. But the fact is, the rotten securities investors bought held the highest quality ratings possible. Mortgage backed securities with an over fifty percent likeliness of failure were labelled as AAA, the safest rating possible. This was just pure deception, and the banks and lenders hawking these products were well aware of it.

Throughout the economic hardship of the past five years I have taken solace in the idea that one day justice would be served and the big banks would see their due day of reckoning. Watching the government pouring our tax money into their coffers has been discouraging, to say the least, but I always knew it wasn’t going to save the institutions in the long run. It just wasn’t enough money. During the boom years the financial industry created eight trillion dollars of phony housing wealth through the origination of property loans, refinancing contracts and derivatives. The bubble popped when the bill came due and homeowners found they just didn’t have the funds to pay up.

Banks found they were facing insolvency. They realized they’d never get the money back on trillions of dollars of bad loans they’d made. They called it a national emergency and convinced us the whole economy would crash and burn if they didn’t get some support. Under President George W. Bush, a stimulus package was crafted in Washington to prevent the economy from tumbling into depression. The banks gladly took the government stimulus money and used it to bolster their falling bottom lines. The economy crashed anyway, but the banks were saved. Or were they?

The problem is, the debt load was just too big for most banks to bear. Stimulus money helped bolster reserve funds, but wasn’t near adequate to cover imminent losses. Foreclosures began to rise as homeowners found they were unable to make payments on loans they should never have been approved for. Banks repossessed properties, but in most cases could not sell them for enough to cover the amount owed on the loans due to deteriorating housing prices. Banks needed accounting rules to change if they were to avoid collapse. And so the rules were changed. A new provision was established that would allow banks to keep housing stock on their books at the value it held when they’d made the loans. In other words, instead of valuing the properties at what they would actually sell for in the falling market, they were able to value them at the inflated prices they’d been appraised at during the bubble years. This allowed banks to claim their assets were worth far more than they actually were, which made them look far better capitalized and healthier than they actually were.

You can see the charade that was put into place here. This new accounting approach was really just a bit of trickery to keep up appearances in the short run, but was clearly without any power to fix the underlying problem of potential insolvency… extend and pretend, a bit of con to hide the con.

If they had to be honest, most banks would be in much worse shape than we realize. Many might even be out of business. In fact, we have seen a record number of banks go under since the beginning of the crisis and more follow suit every week that passes. The nation’s largest banks have been protected. Deemed “too big to fail” by the powers that be, they have not been allowed to see the consequences of their bad investments. Capitalism has not been allowed to run its course. The press reassures us that banks are back on solid ground, but it is highly unlikely. Impossible, really. The bubble was too big, and its deflation is still underway.

The irony is the housing bubble was created in large part by the very system that is now threatened with collapse as the bubble deflates. The financial industry brought this fate upon itself. The Frankenstein monster they’d breathed life into escaped from the castle and tore apart the village, but is now tearing at the kitchen door trying to get back inside. We might imagine that in time, when all the accounting tricks and shell games are forced to their natural ending, justice will finally be done. Banks will eventually have to pay the piper for the havoc their monster wreaked upon the village as they cherry picked the loot left in its path of destruction. At least, I have taken solace in this thought as we’ve endured the terrible injustices and torment the economic crisis has wrought upon the poor and middle classes while the rich banking class prospered.

How was the great heist pulled off? Just how badly have banks been behaving? The roots of today’s crisis can be traced at least as far back as Reagan’s presidency and the onset of an era of deregulation, but at the heart of the recent collapse lies the housing bubble. The banking industry, with its ties to real estate financing, was key in blowing the bubble. There are numerous offenses still to be properly investigated regarding bank misbehavior, from fraudulent paperwork on loans to mass tax evasion due to the failure to pay fees on deed transfers and mortgage registrations. But the worst of the criminal activity lies in the creation and marketing of mortgage backed securities. This involved a systematic global con with banks using the complexities of the securitization process to disguise highly risky toxic assets as extremely safe investments, in order to steal vast sums of money from the unwitting public.

Heading up the Federal Reserve at the inception of the housing bubble was Allan Greenspan, who set the stage with his anti-regulatory stance and his implementation of artificially low interest rates. He failed to address the risk of fraud in the derivatives market when in 1998 he stifled warnings from of the Commodity Futures Trading Commission regarding inadequate transparency and regulation of mortgage backed securities. Banks lent money to corrupt companies like Countrtywide and New Century, who made extremely risky loans, cut them up into tiny pieces, mixed the pieces all up with a few clippings from healthier loans and bottled the mixture with a AAA rating on the label. The lenders then sold this swill back to the banks at an outrageous profit. They did this for years, creating huge sums of money for banks to lend out in order to create more toxic securities. The practice ultimately ruined millions of peoples lives globally and decimated the economy.

To justify their actions in creating toxic mortgage backed securities, banks used the sort of logic that says if you mix a small amount of rotten meat into a large amount of good fresh meat only a few folks will get sick eating the hamburgers made from it. The problem was the ratio was skewed and most of the meat going into the mixture was rotten. So basically everyone got sick eating the stuff, eventually even the banks themselves. Despite the Federal Reserve’s spending billions buying up toxic securities from banks during their latest attempt at quantitative easing, banks are still sitting on huge pools of mortgage backed securities and other derivatives of questionable worth that continue to decline in value. And now the piper is calling for his pay. No one knows exactly what these assets are worth, due to their complexity and to the fact that housing prices are still falling, so we cannot even properly assess the financial standing of most large banks today.

Now the government is involved again, busily cooking up a brand new rescue plan for the financial industry. That’s right, rather than conducting a proper investigation into the criminal behavior of the banking sector, the government is attempting to find a quick fix by throwing more money at the problem. It is pretty horrific. It looks like a cover up. I am shocked, frankly. But, this is my folly. Why would I expect anything different from Washington? They’ve been in bed with the big banks from day one, through the blowing of the bubble and through its collapse. This is probably due to the fact that the biggest players in government economic policy came out of the banking industry, like Secretaries of the Treasury from the past three administrations, Larry Summers, Henry Paulson, and Tim Geithner, for example. This is cronyism at its finest. Look at the net worth of these guys. They’re all very wealthy and most likely profited in some capacity from the greatest rip-off known in Western history, themselves. Do you think they’re going to be looking out for your best interests? Maybe if you’re a Wall Street fat cat!

With so many bankers in the kitchen, the latest plan to deal with the mortgage crisis looks nothing like justice. Though Obama resisted it initially, he has been swayed into agreement. His administration, along with the banks and the state attorneys general have come up with a deal that would allow the culprit banking industry to walk away from a generation of unparalleled fraud practically unscathed. For a combined penalty fee of just $20 billion, to be shouldered by the entire banking industry, all future obligations associated with the mortgage backed securities fiasco would be dropped. The deal would also block efforts by defrauded investors and victims of unfair foreclosures to obtain any relief through the civil court system. The settlement amount of $20 billion would go toward more useless loan modifications and counseling for distressed homeowners.

This plan is so outrageous I don’t know where to begin my criticism. The most striking injustice is, of course, the amount the banks would be held responsible for… or NOT held responsible for, perhaps I should say. We are talking about an $8 trillion dollar housing bubble – an $8 trillion dollar loss of wealth – and the whole banking industry gets off with a combined fee of $20 billion and no criminal investigation? In 2008 the state pension of Florida alone lost more than $62 billion, and that’s a drop in the bucket of what the damage will have cost by the time this thing runs its course. To add insult to injury, the banking industry is balking at paying even that amount and so it will likely be negotiated down.

So who is left to ride in on horseback and upset the pots? There is one ray of hope, and it shines from the scales of New York Attorney General, Eric Schneiderman. He has taken a stand against the proposed deal. He is conducting his own investigation into the mess of toxic securities and refusing to sign on to the new deal. In order for it to fly, the proposal has to have all 50 states along with the federal government on board. It can’t move forward without his participation. Insiders are furious, but he’s not backing down.

“The attorney general remains concerned by any attempt at a global settlement that would shut down ongoing investigations of wrongdoing related to the mortgage crisis,” a spokesman for Mr. Schneiderman told the press.

So there is hope still. Perhaps our brave maverick spokesman will save the day yet. In the meantime, purveyors of the new settlement remain intent on stamping out any spark that might lead to actual justice being done, and are doing all they can to sugar coat the bitter pill and get it down the throat of the public. It is being touted as a grand new effort to help troubled homeowners. With his approval scores hitting new lows these days, it’s just the kind of promo Obama needs as he heads into next year’s elections.

Alisa Finelli, a spokeswoman for the Justice Department had this to say promoting Washington’s corrupt new proposal: “The Justice Department, along with our federal agency partners and state attorneys general, are committed to achieving a resolution that will hold servicers accountable for the harm they have done consumers and bring billions of dollars of relief to struggling homeowners – and bring relief swiftly because homeowners continue to suffer more each day that these issues are not resolved.”

Whoa. Beware the justice of the Justice Department! In their arguments to support the passage of this new plan they have been careful to keep the focus on issues surrounding foreclosure improprieties like “robosigning” and the apparent prolific use of forged documents, but implementation of the plan would also require attorneys general to sign broad releases preventing them from bringing further litigation on all other matters relating to improper banking practices. This would include anything to do with the vast reaching white collar criminal heist banks took part in to turn crap loans into AAA securities and foist them on the public.

So as the rich grow richer and the poor grow poorer across the ever widening economic divide in this country, the chefs of Capitol Hill are busy preparing their new concoction for the marketplace. Something will be served cold, but it won’t be vengeance and most certainly won’t be justice. More likely they’ll be serving up something else to make you sick. Probably best to order off the menu. I’ll be sitting at Schneiderman’s table.